What Happens When the Chips Are Down

F5

Semiconductors

Volume 2

What Happens When the Chips Are Down

The pandemic exposed glaring weaknesses in semiconductor production, sending shock waves through the global economy. To understand the new power dynamics, look no further than the auto industry.

Words by Patrick George

Photos courtesy Getty Images, GlobalFoundries, Toyota

It is highly unlikely anyone will feel real nostalgia for the year 2020, soon or ever. But recall the commercials you saw on TV around this time three years ago. With somber music playing in the background, they usually went something like this: “In these uncertain times…buy a Kia Telluride.” 

At the height of the Covid-19 pandemic, that’s exactly what happened. People bought cars. And VR headsets. And PlayStations. And Peloton bikes. And soon enough, semiconductors — the tiny, typically silicon-based chips that are crucial to all of those things and almost anything else with an on/off switch — became a scarce commodity. 

Despite some recovery, we’re still feeling the effects of the now-infamous “chip shortage,” even as governments and industries worldwide conjure innovative, multibillion-dollar efforts to ensure this doesn’t happen again. Last year, President Biden signed into law the CHIPS and Science Act of 2022. It’s an unprecedented $280 billion effort to bolster America’s local chip-making ecosystem and effectively create one that’s ready for a new age.

But that’s a very tall order. After decades of America’s outsourcing to other countries, U.S. chip production infrastructure is woefully ill-equipped to produce the advanced, bleeding-edge semiconductors needed for the consumer devices of the future, like electric and connected cars.

“In 2021, auto prices drove one-third of all inflation, primarily because we didn’t have enough chips to keep putting cars on the road,” Michael Schmidt, the CHIPS program office director, told Huge Moves in an email. “Medical device manufacturers have had trouble procuring the chips they need for pacemakers, heart monitors and other devices that keep Americans alive.”

Fast-forward to today, and the question of where and how a nation can procure chips is a national security issue. Many seeking solutions are looking to the automotive industry for innovative answers — because cars have emerged as a kind of poster child for the semiconductor crisis, and the path to an electric recovery.

Toyota: A Chip Shortage Case Study 

“Frustrating.” That’s the one-word answer Jack Hollis gives to describe the state of the chip shortage, even in mid-2023. “Understand that it is real.” 

Hollis would know. He’s the executive vice president for sales at Toyota in North America, which weathered the chip shortage better than most but has still been hit hard. Some of its most popular models, like the RAV4 Hybrid, remain tough to find these days with all the bells, whistles and choices buyers were used to before 2020. Toyota still defended its title as the world’s biggest automaker at the end of 2022 by selling 10.5 million cars worldwide

“It was a phenomenal year, globally,” Hollis told Huge Moves. In the U.S., however, 2022 sales were down nearly 10% from the previous year. “Demand for Toyota products is still so much greater than the supply.” 

In America, new car sales collapsed at the onset of the virus in 2020 as the country shut down and people held off on big purchases. But sales quickly rebounded, driven by ultra-low interest rates and a lack of other travel options

As a result, demand for chips skyrocketed. But the workers in the plants that made them kept getting sick and thus were unable to work; likewise with the countless people involved in the supply chain along the way. Moreover, semiconductor suppliers found their order books inundated for video game consoles, personal electronics and appliances; the chip industry itself couldn’t keep pace with erratic market shifts, and automakers took the hit. 

“If automotive seats or fuel injectors are needed, suppliers step up and fill the need. When suppliers and automakers stepped out of line for semiconductors, they were sent to the back of the line, since chip makers didn’t prioritize the automotive industry,” said Sam Fiorani, the vice president of global vehicle forecasting at research firm AutoForecast Solutions.

Automotive chips often use older designs because they’re proven and reliable, Fiorani said; you don’t want any computer-related surprises behind the wheel. “These chips make less money for semiconductor manufacturers, who would rather make the modern, and more expensive, chips needed for the latest gaming system with quick 3D graphics,” he added.

Suddenly, new cars were nowhere to be found on dealer lots as automakers struggled to get completed cars out the door; ones that did ship often lacked key features they may have had before the pandemic, like HD radios, advanced driver assistance systems or even navigation. (“You want a 2024 RAV4 for the fourth quarter? Yeah, unless you want black or white, you’re gonna wait until 2025,” Hollis joked.)

What’s more, Hollis said, the auto industry’s appetite for semiconductors is only growing. For example, Toyota is overhauling its entire future car lineup and manufacturing system to compete with Tesla and new players from China. The auto industry’s rapid shift to electric, connected and ultimately autonomous vehicles will require even more chips than today’s cars do.

A June report from S&P Global Mobility confirms the trend. The research and consulting firm reported the value of semiconductors in vehicles will rise from $500 per car in 2020 to $1,400 by 2028 — imagine how that adds up when you build as many cars as Toyota.

The auto industry’s rapid shift to electric, connected and ultimately autonomous vehicles will require even more chips than today’s cars do.

The automaker had to deploy some decidedly un-Toyota-like strategies to weather the worst of the chip shortage storm. That included stockpiling months’ worth of chips early on in the pandemic, a lesson it first learned in the wake of the 2011 tidal wave and nuclear disaster that hammered Japan’s auto industry. That tactic was in stark contrast to the lean, just-in-time production methods Toyota once pioneered. But here, it worked. 

Tesla’s response was altogether different: It responded by making many chips in-house and rewriting its software to work with the chips that were available (par for the course for an automaker known for its walled-garden approach), creating as much vertical integration as possible rather than relying on outside suppliers. As a result, Tesla largely hasn’t been impacted by the chip shortage compared to other automakers, and indeed sold almost half a million EVs globally in the second quarter of this year.

Other automakers have not been so lucky. General Motors, for example, had a stockpile of 95,000 unfinished cars around this time last year, and Honda scaled back one of its Japanese plants by a stunning 40%. “Through the end of 2022, production of an estimated 14.95 million vehicles around the world has been affected by a lack of chips, and another 2 to 2.5 million will be lost in 2023,” Fiorani said.

Car companies are moving fast to address this. Nearly all automakers are forming dedicated teams to revamp how chips are designed and sourced, or are looking for semiconductor partners to secure robust supplies for the future.

Earlier this year, GM inked a deal with New York–based semiconductor manufacturer GlobalFoundries. Under the terms of the deal, which will last at least three years, GlobalFoundries will have a dedicated production capacity exclusively for GM. Furthermore, production will happen in upstate New York. (The same company was also in talks with Ford as of late 2021, though it remains unclear what, if anything, has come from that.)

One thing is clear: A massive amount of public investment has been deployed to make sure America doesn’t drop the ball again.

The Government’s Huge Move 

In 1990, the U.S. was responsible for 37% of the world’s commercial semiconductor manufacturing. Last year, that share dwindled to just 12%. Decades of offshoring have centralized much of the world’s chip manufacturing in East Asia, particularly Taiwan.

A 2022 study from the Center for a New American Security reported Taiwan boasts more than 50% of overall global semiconductor manufacturing capacity; the next-closest leader is South Korea, at 19%. And those countries didn’t just make semiconductors — they figured out ways to design better ones, leaving America at a major R&D disadvantage, as well as a manufacturing one.

The CHIPS and Science Act is designed to tackle those problems head-on. It’s a funding initiative worth about $280 billion over 10 years, including allocating $52.7 billion to direct grants and loans for companies that want to boost American chip R&D and manufacturing. Companies that apply for funding will compete for massive financial help to develop and make chips in the U.S. The act was backed by chief executives at numerous automakers and semiconductor suppliers.

“By the end of the decade, the U.S. will have at least two new large-scale clusters of leading-edge logic fabs [semiconductor fabrication plants], with each cluster including multiple commercial-scale fabs, a large and skilled workforce, nearby suppliers, R&D facilities and specialized infrastructure,” Schmidt said. Other goals include having the U.S. be home to several facilities for semiconductor packaging — “the process of putting fabricated chips into containers that will ultimately be embedded in products” — and vastly increasing the production of current-generation chips as well.

To give an idea of its scale, the Bipartisan Infrastructure Law is allocating a comparatively paltry $7.5 billion to grow the public EV charging networks in America. “The CHIPS and Science Act is already starting to indirectly pay dividends; the department hasn’t given out a single award yet, and we’ve already seen $231 billion in private-sector investment in semiconductor production,” Schmidt said.

Because the CHIPS Act was a bipartisan effort with committed funding, sources familiar with the program say it isn’t going to vanish even if the White House or Congress changes hands in the 2024 election and beyond. The net effect of all this is that more companies will be encouraged to boost their semiconductor manufacturing.

“Bringing semiconductor production to the United States through the CHIPS Act will add some long-term security to domestic production of many items, including vehicles,” Fiorani said. “As the industry transitions from internal combustion engines to battery electric power, there is a shift underway toward more modern chips that could make them more desirable for chip makers to produce.”

With a bigger and more cutting-edge chip ecosystem at home, U.S. automakers and companies in other industries won’t be as singularly reliant on Taiwan as they are now — or drawn into a potential conflict there.

“Relying on Taiwan, China and other foreign countries to supply chips for industries like vehicle production puts that supply chain at risk of political tensions between, or within, countries,” Fiorani said. “Bringing the chip production into the U.S. will, hopefully, secure the supply from these outside influences.”

China likely feels the same way; it’s dumping about $140 billion into its own domestic chip industry. The CHIPS and Science Act is designed to ensure that America doesn’t cede dominance by limiting recipients of funding from investing in semiconductor expansions in countries like China, Russia and Iran.

“We will be evaluating all applications based on how they advance U.S. economic and national security, and we will be conducting rigorous due diligence to ensure we’re making the right choices,” Schmidt said. “But this is not a zero-sum game: We expect that companies will be diversifying their footprints globally, not just in the United States.”

The Road Ahead 

As disruptive as the chip shortage has been, it could yield positive momentum — provided that semiconductor-dependent companies adjust their tactics to face this new reality. They’ll need to act more like Tesla, more able to nimbly retool how products are built; or GM, eager to partner with companies taking advantage of huge government grants for dedicated chip supply lines; or even Toyota, willing to defy certain core business tenets in order to ensure a robust inventory for the future.

Semiconductors will soon be more important than they’ve ever been for tomorrow’s consumer products, and automakers in particular will need more speed and more preparedness than they’ve ever had to meet this moment.

If companies are still looking at semiconductors the way they did in 2019, they’re in for a world of hurt.

It’s also crucial to remember that unfortunately, the initiatives in the CHIPS and Science Act won’t provide an overnight fix. Like the battery plants going up in numerous states to power the next generation of American-made EVs, these semiconductor factories will take years to ramp up. 

“Building a new fab is an expensive undertaking, with tens of billions of dollars required before one chip rolls out of the factory,” Fiorani said. And some experts say there remains a semiconductor-related skills gap of employees equipped to design and build the next great powerhouse. America has ceded semiconductor expertise to other countries for so long that it has to catch up on multiple fronts.

As to whether the chip shortage seems to be easing, that depends on who you ask. In January, a study from the German Association of the Automotive Industry predicted a 20% drop in global car production by 2026 if measures aren’t taken to address the semiconductor shortage. And an uneven global economy complicates further recovery.

Fiorani, on the other hand, seems much more optimistic. “The situation is improving and should be a relatively minor annoyance in 2024,” he said.

Hollis, Toyota’s North American sales chief, also sees a light at the end of this tunnel: “I think this is something we’re going to deal with all the way through the rest of this calendar year,” he said. “I think in 2024 we can be more reliant upon the chip supply.”

Patrick George is a journalist covering the future of the automotive industry. He is co-host of the Vox Media podcast docu-series “Land of the Giants: The Tesla Shockwave.”

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